ILEC 3Q11 Quarterly Results: Frontier Communications

Residential Customers Fall 10% in 3Q11

While the popular strategy amongst the ILECs of late has been to shift focus away from residential service to the business community, Frontier (NYSE:FTR) has chosen a different path.  As other LECs have transitioned into managed services and data center operations through M&A, Frontier put its stake in the ground when it acquired 4.8m access lines from Verizon (NYSE:VZ). As such, given the industry-wide trend of access line losses, Frontier’s sizable subscriber losses and revenue declines in 3Q11 did not come as a surprise.

Frontier lost 10% of its residential customer base YoY in 3Q11, ending the quarter with 3.1m subscribers. A small portion of the sub losses was associated Frontier’s effort to shake some of the unprofitable FiOS customers it acquired from Verizon. While the decline in residential access lines was predictable for Frontier, its loss of 31,000 business customers YoY, or 9.8% of its customer base, is more discouraging.

Frontier ceo Mary Agnes Wilderotter spoke to the $6m decline in commercial/business revenues on the earnings call. “The revenue decline in commercial was really one-time items. And it was clean-up of settlements and disputes that have been out there for a very long time. So we wanted to put all that behind us. That's a one-time issue.”

Donald Chaisson, Frontier cfo, later clarified the “one-time” items amounted for $4.5m-$5m of the $6m YoY decline in business revenues, which indicates the overall trend for commercial revenues was still downward in 3Q11.

Overall the access line losses led to revenue declines of 8% to $1.3b in the third quarter, and net income also dropped 30% to $20.4m. Frontier’s operating results however were not all negative. The company appears to have been successful thus far in realizing the cost synergies it projected when purchasing its Verizon properties. 

Wilderotter provided analysts with an update on the Verizon integration on the earnings call. “We generated $18m of incremental cost synergies (from the Verizon acquisition) in 3Q11. Our total is now $496m, putting us 83% of the way toward our $600m 2012 goal. The largest contributor to the synergies in 3Q11 was the full impact of traffic migration to our own national backbone. We will realize additional synergies as we convert the remaining acquired property systems onto Frontier's legacy system. In 3Q11, our cumulative synergies helped Frontier generate a 47% EBITDA margin.”

Frontier is also in the process of expanding broadband services to its acquired properties. It reached an additional 126k homes in 3Q11 with broadband access, bringing its year to date total to 352k homes. The upgrades to the former Verizon lines should improve monthly ARPU, as Frontier’s legacy access lines generate $85 a month, while ARPU inclusive of the Verizon lines was only $79.22 during 3Q11.

In addition to its broadband expansion efforts, Frontier has inked some reseller agreements in hope of giving its top and bottom lines a boost going forward. The telco has entered into agreements with both of the leading satellite providers, DirecTV (Nasdaq:DTV) and Dish Networks (Nasdaq:DISH), to resell their satellite TV packages and in November it signed a deal with AT&T (NYSE:T) that will allow the ILEC to provide wireless voice and data services to its customers.  Frontier plans to bundle wireless with its satellite TV, DSL and traditional wireline voice services. 

Six Degrees of Separation: Winners, Losers and Movers

CenturyLink Edges Out Windstream for First Place

In the first two years of our “Six Degrees of Separation” analysis, there was little movement at the top of the ranks. NTELOS (Nasdaq:NTLS) edged out Shenandoah Communications (Nasdaq:SHEN) in 2008 for the victory, while Shenandoah

returned the favor in 2009, flip-flopping ranks with NTELOS. This year we crown both a new winner and a new runner up. Envelope please. And the winner of the third annual “ILEC Six Degrees of Separation” is… CenturyLink (NYSE:CTL)!

Over the past three years, CenturyLink has steadily improved its performance in our Six Degrees tests, moving up in rank from 10th place in 2008, to 4th last year, to 1st in 2010. Aided by its acquisition of Embarq, CenturyLink finished on top of the growth and return to shareholders categories in this year’s analysis. Its sample best weighted average rank of 4.48 is slightly stronger than Shenandoah’s winning rank of 4.8 a year ago. Right on CenturyLink’s heels was runner-up Windstream (Nasdaq:WIN) with a weighted average rank of 5.23. Both LECs were awarded A’s for their overall performance.

The only downside to winning: when you’re at the top, there’s no place to go but down. Just ask the 2008 and 2009 Six Degrees champs. Last year’s winner, Shenandoah, dropped twelve spots overall, while NTELOS fell nine spots. We documented Shenandoah’s fall from grace throughout this year’s analysis as its efficiency, growth and profitability metrics all deteriorated in 2010 and its stock price (and long-term performance rank) paid the price. NTELOS’ declines were also widespread, as it went from A’s to C’s in growth, financial condition and efficiency.

The upside movers were less dramatic. Otelco (Nasdaq:OTT) was the biggest gainer, thanks to its first place finish in long-term performance.  It moved up from 9th place to 3rd overall, earning an A- for its efforts. Frontier (NYSE:FTR) also jumped up six spots from a year ago, driven by an improved growth performance after it acquired 4m access lines from Verizon (NYSE:VZ).

While there was a shakeup at the top, the F students remained the same. Fairpoint (Nasdaq:FRP) finished in the basement for a third consecutive year, its average rank improving slightly only because there was one less public LEC (Iowa Telecom) compared to 2009’s sample. New Ulm Telecom (OTC:NULM) also repeated its second-to-last place finish from last year after earning a D- and an F in the most heavily weighted categories (return to shareholders and long-term performance).

In total, the bell curve produced a final grade tally of two A’s, one A-, two B+’s, one B, two B-‘s, one C+, one C, three C-‘s, two D+’s, one D, zero D-‘s, and two F’s. 

Six Degrees of Separation: Public Companies Graded on Growth

Acquisitions Behind Results for the Top Performers

Continuing our Six Degrees of Separation analysis, we move on to the next category of tests: growth. For most ILECs, organic growth has been difficult to generate over the past year. Telcos have relied on improving penetration of their voice customers with Internet and television services, but cablecos have returned the favor, stealing voice customers from the ILECs. Some of the big players meanwhile have grown through acquisition. And while M&A doesn’t always translate into real “growth,” deal-happy ILECs dominated the Six Degrees growth tests this year.

The four areas we have selected to test are growth in OIBDA, free cash flow, connections and OIBDA per connection.

Following up a strong showing in the profitability tests, CenturyLink (NYSE:CTL) topped three of the four growth tests—all but connections—en route to an A+ and a number one finish. Its strong performance was again aided by its 3Q09 acquisition of Embarq. Enjoying an additional six months of Embarq’s operations, CenturyLink’s OIBDA was up $1.3b and 58% YoY. Embarq’s OIBDA in its six months prior to acquisition: around $1.3b.

The Six Degrees tests also rewarded Frontier’s (NYSE:FTR) acquisition of 4m access lines from Verizon (NYSE:VZ). Frontier posted the best connections growth of the public ILECs in 2010—a near three fold gain—while also experiencing OIBDA and free cash flow growth (54% and 32%). On a down note, Frontier’s OIBDA per connection did suffer in 2010, as it acquired some of Verizon’s less profitable access lines. The top mover in the growth rankings from 17 to 4, Frontier improved its grade from an F to an A-.

Moving to the back of the class, Warwick Valley Telephone (Nasdaq:WWVY) would have swept last place in all four tests, if it weren’t for Fairpoint (Nasdaq:FRP) shedding a higher percentage of connections. A three-time recipient of an F in growth, the New York-based LEC posted negative OIBDA in each quarter of 2010, relying on its investment in the Orange County-Poughkeepsie Limited Partnership to counteract operating losses. Warwick Valley will need to generate positive operating cash flow before it can move up the ranks in OIBDA, free cash flow and OIBDA per connection growth. Similar to other LECs, WVT has recently turned to M&A for growth with its purchase of cloud provider Alteva in 2011.

The decline of last year’s Six Degrees title holder, Shenandoah Telecommunications (Nasdaq:SHEN), continues in the growth category thanks to the same factors that adversely impacted its profitability rank: higher wireless payments to Sprint, network upgrades and a $3.2m acquisition charge associated with its JetBroadband purchase. Its OIBDA, free cash flow and OIBDA per connection all declined from 2009 levels. Shenandoah won the silver medal in growth last year, but finished 13th in 2010, dropping it from an A to a D+.

Looking ahead to next year, M&A again should significantly impact the Six Degrees growth category. In 2011, CenturyLink has closed its Qwest acquisition and agreed to purchase data center giant Savvis, while other ILECs like Warwick Valley have purchase cloud/managed service providers.

Frontier Communications Showing Some Improvement in the Second Quarter

Frontier Plans to Exceed Initial Expected Synergies

It’s been one full year since Frontier acquired 4.0 million access lines from Verizon, more than doubling the size of the company.  Over that period, revenues declined from a pro forma $1,434 million during second quarter of 2010 to $1,322 million during second quarter of 2011, a decrease of 7.8%.   Access lines declined from a pro forma 6.009 million as of June 30, 2010 to 5.489 million as of June 30, 2010, a decrease of 8.64%.  And while those results don’t look promising, Frontier’s second quarter 2011 results showed that the company is making progress on its original goals of the acquisition, namely, increasing broadband customers and penetration rates, and realizing roughly $500 million in synergies.

Going into the acquisition, one of Frontier’s stated main goals was to improve broadband penetration rates at the acquired properties to drive customer retention and revenue growth.  During the second quarter, the company expanded broadband availability to 142,000 homes, bringing the total expansion of broadband availability since the acquisition to 466,000.  Which, Frontier said during in its Q2 2011 Earnings Call, puts the company on track to meet its network expansion plans.  However, Frontier’s net 12,300 DSL subscriber adds during the second quarter are just not good enough to stabilize its top line (especially when you consider the company lost 4,900 FiOS data customers). 

According to Frontier’s chairman and ceo, Maggie Wilderotter, the low net add amount was partly due to “unacceptable levels of network congestion” that she believes will be fixed by the end of the third quarter of 2011, to which she indicated should lead to higher growth and net broadband additions.   Overall, broadband penetration has been improving at the acquired properties, going from 26.5% at June 30, 2010 to 29.7% at June 30, 2011, an increase of 12.0%.  On a pro forma basis, Frontier’s overall broadband penetration rate increased from 28.2% as of June 30, 2010 to 31.2% as of June 30, 2011.  The increase in the penetration rate contributed to an increase in average monthly total revenue per access line from a pro forma $78.51 as of June 30, 2010 to $79.42 as of June 30, 2011.    

While the gains in broadband customers aren’t yet as strong as Frontier would like to see, the company is on track to realize better than originally announced synergies.  During the second quarter of 2011, Frontier realized an additional $14 million in cost synergies due to backbone circuit migration, contractor reductions, and other projects on its target list.  This additional savings brings the annual cost synergy run rate to $424 million, which is 20% of the annual cash operating expenses of the acquired properties just prior to closing the deal according to Donald Shassian, Frontier’s cfo.  Furthermore, Frontier says it has identified additional cost savings related to exiting certain leases by the end of 2011 and renegotiating third-party software expenses.  As a result, the company has increased its 2011 cost synergy run rate target from $400 million to a range of $475 million to $500 million and the 2012 cost synergy run rate target from $550 million to $600 million, 20% greater than the $500 million anticipated synergies when the deal was originally announced in 2009.

Although its second quarter financial results did show some improvement, Frontier still has a lot of work to do to stabilize its top line.  The small improvements in broadband penetration are encouraging and the improved cost savings will help to preserve its dividend in the short-term.  But, Frontier still has a lot of work to do to improve its broadband penetration rate to preserve its dividend over the long-term.

1Q11 Connections: DBS Connections

CenturyLink Closes on AT&T as Largest Reseller; DirecTV Extends Lead Over DISH 

As a whole, the public ILECs reported an increase of 34k DBS subs during the first quarter of 2011 and 233k for the year—“reported” however, being the key term.  Verizon (NYSE:VZ) no longer breaks out its DBS subs, but at last estimate it had around 1.45m DBS customers.  That was in 2Q10, however, prior to Frontier's (NYSE:FTR) acquisition of 214k former Verizon DBS customers.  

The merged CenturyLink/Qwest (NYSE:CTL) grew DBS subs at a strong pace in 1Q11, and post merger could soon overtake AT&T (NYSE:T) as the top-ILEC provider of DBS services.  Elsewhere, Frontier reported strong DBS customer growth of nearly 140k subs in 1Q11. 

AT&T has shed DBS customers steadily since 2Q10, and lost 11.3% of its customer base in the year ended March 31, 2011. Logically, AT&T also provides the best proxy for Verizon as both providers have pushed similar video services—U-Verse and FiOS—over the past year. One could safely assume that Verizon has experienced similar DBS losses, as it transitions its customers from DBS services to FiOS.

Among the DBS giants, DirecTV (Nasdaq:DTV) extended its connections lead over DISH Networks in 1Q11, adding 184k subscribers.  DISH Networks (Nasdaq:DISH), however, showed signs of life, adding 58k subs after three straight quarters of losses.  Despite its 1Q11 growth, DISH lost 1% of it customer base over the past year, during which DirecTV has grown its connections by nearly 750k.